How investments are taxed

Investments are designed to earn income and are subject to taxation in the same way as income earned from employment. When you understand that, you can do something about your tax liability.

Various types of investments are taxed differently, for example, Income Tax, Capital Gains Tax, and Stamp Duty Tax. Certain investments do not attract tax. 

This article will go into detail about various types of income and how taxation accrues for each. 

Income Tax

Income Tax is payable on receipts of income, such as interest or dividends from investments. The rate of taxation depends on the tax band an individual falls into and whether the investment is an ISA. 

Personal allowances: this refers to the amount of income an individual can earn before becoming eligible to pay income tax. Those receiving less than their personal allowance are exempt from paying income tax.

Tax band categories indicate the percentage rate of income tax payable based on how low or high an individual's earnings are.

Dividends and interest payments are two types of income for investors. Dividends are distributions rendered to shareholders by corporations. Investors of Government and corporate bonds receive interest payments.

  • Dividends

A dividend is payable from the profits by a company to its shareholders. Shareholders can accept the dividend as income or may opt to reinvest it in additional shares. 

In the 2020/2021 tax year, the first £2000 of dividend income is exempt from taxation. After that, the tax will be calculated based on the three tax bands relevant to the individual. For example, basic rate earners pay 7.5% tax on dividends beyond £2000. Higher rate earners 32.5% and additional rate taxpayers 38.1%

  • Interest Payments

Interest is regular payments made at a specific rate. Such amounts are made to investors' financial institutions over and above the principal sum. 

Basic rate taxpayers have a £1000 personal savings allowance on interest earned. After that, they pay 20% tax. Higher rate taxpayers will pay 40% after an allowance of £500. Additional rate taxpayers have no personal savings allowance on interest earned and pay 45% of their interest earned to HM Revenue and Customs.

Capital Gains Tax

Capital refers to a person's or a company's wealth in the form of money or other assets that can be used to start a business or invest.

The profit made from the sale of a non-inventory commodity, such as stocks, bonds, precious metals, or real estate, is subject to capital gains tax.

Profit is the difference between the amount spent and the amount earned on the sale of an asset.

An individual will only pay tax on the profit earned after deducting the applicable tax-free allowance. 

Stamp Duty Reserve Tax

Stamp Duty Reserve Tax (SDRT) of 0.5% is levied against purchases of UK shares online. This tax is deducted at the time of purchase. SDRT is a once-off transaction. If the value of the shares increases, there is no additional tax to pay. 

Investment funds, which include a portion of shares, are not liable for SDRT. No tax makes them very attractive to investors. 

Tax on Savings Interest

Individuals also receive interest on their investments without having to pay taxes on them. The explanation for this is that there are several tax-free interest allowances:

*Personal Allowance

*Starting rate for savings

*Personal Savings Allowance

The allowance thresholds above differ depending on other income earned by the individual.

These allowances are allocated every year within the tax year, which runs from 6 April to 5 April of the following year.

Tax on Shares

  • Buying shares

When an individual purchase shares a tax of 0.5% is levied against each transaction.

Shares purchased electronically will attract Stamp Duty Reserve Tax (SDRT). However, shares purchased using a stock transfer form ensures SDRT is due on transactions over £1000. 

Tax is payable on the following purchase transactions:

  • Existing shares in a UK company

  • An option to purchase shares

  • Interest in shares

  • Shares in a foreign company that has a share register in the UK

  • Rights arising from shares, for example, rights when new shares are issued.

An individual avoids taxation when:

  • is given shares without money exchanging hands

  • subscribes to a new issue of shares in a company

  • buys shares in an open-ended investment company (OEIC) from a fund manager

  • buys units in a unit trust from a fund manager

Buying foreign shares outside the UK does not attract SDRT. There may, however, be other tax implications. 

  • Selling shares

Disposing of one's shares or investments for a profit or gain results in Capital Gains Tax being due. 

These shares and investments may include;-

  • Shares not held in an ISA (Individual Savings Account) or a PEPP (Personal Equity Plan) ( PEP)

  • Units in a Unit Trust

  • Certain Bonds (excluding Premium Bonds and Qualifying Corporate Bonds)

The investor calculates the tax liability, considering his Capital Gains Tax allowance for the tax year.

When an investor gives his shares to a family or a charity, they are not subject to tax. Furthermore, when the following conditions are met, no tax is due:-

  • Shares from an ISA or PEP

  • Shares in Share Incentive Plans (SIPs)

  • UK Government gilts (including Premium Bonds)

  • Qualifying Corporate Bonds

  • Employee Shareholder shares